EU Sets Sights on Tax Privileges in Special Economic Zones

The European Commission wants stricter guidelines for the “tax privileges’’ some European Union countries permit within special economic zones in their jurisdictions, to enhance economic development.

The confidential proposal for the guidelines, seen by Bloomberg BNA, is currently under discussion within the EU’s Code of Conduct Group for Business Taxation, tasked with rooting out harmful taxation competition. The same group also is drawing up an EU tax haven blacklist, set for finalization by the end of 2017.

The commission’s proposal insists that the tax breaks in the special economic zones—often set up in remote regions or even islands within a jurisdiction—should be offered in ways that are “commensurate’’ with “real economic activity.’’

The call for the stricter tax privilege approach comes amid mounting concerns that some areas that benefit are using them in ways that create harmful competition.

Madeira Accused

This is especially true in the case of Madeira, a Portuguese island region in the Atlantic Ocean, recently deemed a “tax haven’’ in the EU by the European Green Party.

Besides Portugal, EU member countries such as Spain, Poland, Latvia and Lithuania allow the tax privileges in certain parts of their territory.

In its proposal, the European Commission stated that if any of the following are allowed in a special economic zone with tax privileges, they should trigger “scrutiny” by the Code of Conduct Group:

•  access to the zone that favors foreign investors or that discriminates against domestic investors, or if the tax benefits available to companies operating in the zone specifically favor transactions with non-residents or discriminate against domestic transactions;
• regulations that place restrictions on activities that require a substantial economic presence;
• regulations that don’t require a commensurate link between real economic activity carried on within the zone—such as distribution and manufacturing activities and activities that generate employment, assets and investments—and the profits that benefit from the tax privilege, or if there is a lack of regular tax audits verifying such a commensurate link;
• highly mobile activities typical of the banking or insurance industry, intra-group services or activities holding equity participation and that earn only dividends, and the allowance of capital gains in the zone;
• a lack of regular tax audits verifying that the profits accruing in the zone are commensurate with the business activities carried on within it;
• terms and conditions for establishing a zone, for being allowed to operate in the zone and for the benefits available for companies operating in a zone aren’t clearly defined in public legislation or aren’t limited in time, or permission to establish a zone or to be active in a zone is subject to discretionary powers.

Treaty Recognition

The need to help island regions such as Madeira and the Canary Islands, which is part of Spain, is recognized in EU treaties. In the case of Poland, there is an economic zone that provides corporate tax income reductions for companies carrying out investments in geographical areas the Polish government has determined need special assistance.

The issue of the tax privileges allowed in EU member state economic zones has taken on more importance as the EU draws up its tax haven blacklist. Critics within the EU and outside the EU claim the bloc is using double standards by taking a tough line on countries and tax jurisdictions beyond its borders compared to those within.

The European Green Party has been one of the most outspoken critics on the issue. It issued a report earlier in 2017, “Madeira—a Tax Haven Approved by the European Commission.” The political group said there are very few jobs created by the tax breaks allowed in the Portuguese island.

“The goal was to attract companies that create jobs for Madeira’s citizens and boost the local economy,” the report stated. “But in fact, mainly multinationals and rich individuals have been benefiting from the low taxes while other countries have been losing billions of tax revenues.”

Commission Proposal Criticized

Sven Giegold, a German European Parliament member from the European Green Party and one of the law-making body’s most prominent tax experts, told Bloomberg BNA the proposed criteria by the European Commission, especially the one concerning links with economic activity, are insufficient.

“The substantial test needs to be specified, otherwise the abuse of free zones will continue,” Giegold told Bloomberg BNA in an April 6 email. “Even after the Madeira revelations, member states are not willing to end the abuse of special economic zones.”

Giegold added that because the EU Code of Conduct Group for Business Taxation hasn’t taken a stricter approach to date on the issue, the European Commission competition authority must adopt strict state-aid guidelines.

Commissioner Margrethe Vestager “holds the keys in her hand to end the tax misuse of economic zones,” Giegold said.

The European Commission told Bloomberg BNA that it regularly monitors state aid granted in the form of fiscal benefits in special economic zones and if it finds that state-aid rules haven’t been respected, “we can decide to open a case.”

According to an official with Malta, which currently holds the rotating EU presidency and therefore chairs the work in the Code of Conduct Group for Business Taxation, member states have yet to agree on the new guidelines put forward by the European Commission.